Function of Inflation in Different Economies

Read this article to learn about the important function of inflation in different economies.

Inflation in Underdeveloped Economy:

Keynes has distinguished between bottleneck inflation and ‘true inflation’ the latter sets in after the level of full employment has been attained.

In underdeveloped economies the nature of inflation is essentially ‘bottleneck inflation’ which sets in much earlier than the level of full employment income is reached.

The bottleneck inflation is caused when the supply of the factors of production becomes limited and all increases in money income result in price increases.

Truly speaking, it is not easy to describe the exact nature of inflation in underdeveloped economies, which besides being in the nature of ‘bottleneck inflation’ may also be in the nature of ‘scarcity inflation’ or ‘cost-push inflation or may also be in the nature of ‘prices spiral’ all combined into one. In other words, as money incomes are increased to raise real incomes and employment, shortages of capital, raw materials and other complementary resources start appearing in a pressing form raising their prices. On account of this, inflation in backward economies commences at a stage much earlier than in the advanced economies.

It is on account of this that underdeveloped economies have been described as highly inflation- sensitive. The reasons are obvious. Firstly, there are certain rigidities of extreme type in such economies, manifesting themselves in the lack of responsiveness in the supply side to increased demands, swelling up money incomes, rather than real incomes.

Among these rigidities market imperfections prevent an optimum allocation of resources, impairing the expansion of actual production frontier to the optimum possible. These imperfections include imperfect knowledge, imperfect mobility, imperfect divisible of factors, ignorance of market conditions, rigid social structure and lack of specialization all result in imperfect elasticity of supply.

Secondly, the financial resources for the implementation of financial plans have to be found through deficit financing. Thirdly, the high priorities and preference given to the production of capital goods results in the deficiency of consumer goods. Thus, while money incomes grow, leading to a rise in demand, consumption goods become inadequate pushing up the general price level. Fourthly, the measure and policies to control the inflationary potential remain ineffective. As a result of these factors inflation in underdeveloped economies becomes a barrier to economic development and capital formation.

Inflation in a Mixed Economy:

In a mixed economy, inflation has to be viewed against the forces operating in such an economy. In this type of an economy,-the state activities in the economic field compete with private enterprises for the employment of available resources. The acuteness of competition depends upon the relative role given to the public and private sectors. In India, the public sector has been assigned a leading role in the development of the economy and is expected to grow both relatively as well as absolutely in relation to the private sector. As a result, investment in the public sector will always receive priority and is likely to be in a higher ratio.

extent of economic growth as also the limits to inflation in a mixed economy like India will depend upon the tendency for the state and private enterprises to pull together or to pull apart in an effort to catch the available savings i.e., to what extent the two sectors co-operate with each other to share the limited supply of scarce resources.

The public sector seeks the easier solution of creating money and credit to procure the resources it needs and to go ahead. To avoid inflation, it is necessary that the state and private enterprises should pull together in sharing the savings available and should not compete in a manner that the easy solution of forced saving (inflation) becomes necessary to meet the investment demands of the state.

Inflation in a Socialist Economy:

It is interesting to note the nature and significance of inflation in a totalitarian socialist economy like that of USSR. Inflation in such an economy is resorted to break the vicious circle of poverty and to mobilize the resources for economy development. The fundamental difference of inflation in a socialist economy as compared to the free capitalist economies lies in controlling the phenomenon of inflation and sparing the economy of its evil effects. A socialist economy determines economic activity by prior state plans into which all must fit and only a small sector is left free to private initiative.

A socialist economy can mobilize the savings needed by holding down consumption, increasing hours of work, decreasing leisure, freezing jobs etc., in an all embracing manner—quite impossible in a democratic free economy. Thus, a socialist economy may escape the evil ejects of inflation or cure inflation by means which are not available or practiced in a democratic set up. Therein lies the fundamental difference of inflation as an instrument of economic development in a free market and a socialist economy.